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Bill Gross puts U.S. on notice about debt binge

If the bond vigilantes are ready to ride again, there should be little doubt who will be leading the charge.

Bond guru Bill Gross at Pimco in Newport Beach this week has ramped up his warnings to the Obama administration and the Federal Reserve about the perils of unfettered government borrowing.

In an interview in Time magazine on Tuesday, Gross suggested that Pimco, which manages nearly $1 trillion in mostly fixed-income assets, now feels more comfortable owning German government debt than U.S. Treasury debt:

"There are a number of reasons to have doubts about Treasuries, not just because of America's sovereign risk but also from the standpoint of an over-owned currency [the dollar]. . . . At Pimco we would probably try and substitute for our Treasuries with sovereign bonds of potentially higher quality. Germany looks interesting to us. Germany has problems, but it's in a much better budget situation than the U.S. because of a constitutional amendment three months ago that forces a balanced budget in four years."

Gross, 65, continued with that theme in his January commentary on Pimco’s website, published Wednesday. “The fact is that investors, much like national citizens, need to be vigilant and there has been a decided lack of vigilance in recent years from both camps in the U.S.,” he wrote. “The shifting of private investment dollars to more fiscally responsible government bond markets may make for a very real outcome in 2010 and beyond.”

Historically, “vigilance” on the part of bond investors has meant driving up interest rates to levels that, at least in theory, should force governments to rein in their borrowing and spending.

Pimco in November sharply cut back on holdings of government securities in the firm’s flagship bond fund, Pimco Total Return. It was a smart move: The yield on the 10-year Treasury note has surged from 3.2% at the end of November to 3.8% now, devaluing outstanding Treasury issues.

The next big test for the Treasury market comes on Friday, when the government will report on December employment trends. A better-than-expected report could sent bond yields higher if investors figure the economy is continuing to recover, putting upward pressure on all interest rates.